Considerations for International Taxation- The Fundamentals

In this post, we’ll cover a little bit about how international tax works. The US Internal Revenue Code and its related clarifying regulations, rulings, and cases is inherently complex to begin with (proponents of the system call it “sophisticated”), adding in the layer of international taxation makes navigation incredibly challenging. 

In tandem with our real estate tax deferral series, I’ll be writing a series of pieces about cross border taxation issues here in the US, for those who would like to learn more about the topic.

The Fundamentals

When it comes to explaining international taxation, we usually set the stage with a simple inquiry: “Where else in the world do you pay taxes?” Knowing this first will set us up for a discussion on how your business plans to work within the US and how we can frame a tax plan around it that will result in the overall lowest global taxation paid by you and your company. We can also determine if we can avail ourselves to tax treaties, which are affirmed between your country and the US. In a lot of cases, the tax treaties mitigate or totally avoid double taxation.

The next set of questions we’d want to have answered relate to where and how your income is earned. The character of the income you earned, and subsequently taxed, can dramatically change the outcome of your overall tax bill. Where you earn it can potentially point to where the income should be sourced, which determines which country gets first crack at taxation.

Illustrative Examples

Let’s work through a few examples to help you understand. 

Capital Gains

A non-US person who sets up a brokerage account with E*Trade, a US based brokerage firm, who then buys and sells US publicly traded securities, would not be taxed on the capital gains resulting from these transactions within the US, since under US sourcing rules, capital gains are sourced to the residency of the taxpayer.

However, a non-US person who flies to E*Trade’s headquarters in the US and does some consulting work for them would most likely pay some level of tax to the US, since under US sourcing rules, income earned from labor is sourced to where the labor is performed.

These examples take us to the next points which cover US taxation concepts.

Effectively Connected Income

Primarily, income that is considered to be effectively connected to a trade or business in the US is one that will be taxed by the US. Effectively connected income (“ECI”) covers a wide range of activities, including real estate. As I mentioned in the example above, capital gains are sourced to residency of the taxpayer, which would generally exclude non-US persons from paying taxes on those gains.

Fixed, Determinable, Annual, Periodical

The other source of income that is taxed differently than ECI is any source that is Fixed, Determinable, Annual, or Periodical (also known as ‘FDAP’). In the absence of a tax treaty, this type of income is taxed at 30% In the next post, we’ll dive further into this and illustrate more examples.

In the meantime, I always welcome questions and you may contact me here.

-Karen Park, CPA, MBT